CVW News 2nd Quarter | 2024

Table of Contents

Three Numbers Every Interior Design Business Owner Should Focus On

by Caroline Van Wassenhove, CPA

Originally published on the Dakota Design Company's Guest Expert Interview Series.

THE IMPORTANCE OF CASH POSITION FOR INTERIOR DESIGNERS

One of the biggest challenges interior design business owners face is understanding their cash position. It’s one thing to look at a bank account balance, but it’s another to know what that balance represents. In the interior design industry, there is so much cash coming in and out that it’s imperative for owners to distinguish operating cash from project cash.

Here’s how interior designers should think about it:

Operating cash is the money needed for the company’s day-to-day business activities, whereas project cash is the money specifically designated to complete a project. While operating cash is typically generated from profit, project cash is commonly received in the form of client payments. Clients will typically pay a deposit prior to the start of the project and prior to the purchasing phase which allows designers to make purchases for the project on the client’s behalf.

There are, however, risks associated with this process if not properly executed like:

1. the owner fronting their own cash for purchases throughout the project due to insufficient deposits collected,
2. the project running out of money before its completion because project funds were spent on operating or other non-project related expenses, and
3. insufficient profit generated from the project to sustain and operate the business.

Fortunately, there are different approaches available to interior design business owners to minimize these risks.

1. One approach is to clearly identify how much cash is needed for the project vs how much is needed to run the company via cashflow reporting. The cashflow report can help identify the deposits needed throughout the life of the project to help protect the owners from fronting any of their own cash.
2. Another approach is to safeguard the project funds by using separate bank and credit card accounts for both project and non-project use. This may not only help owners protect their project cash, but it would also allow them to clearly identify the cash remaining to run the company.

THE IMPORTANCE OF PROFIT FOR INTERIOR DESIGNERS

One of the primary goals for any business owner is to make a profit. A simple way to define profit is the amount of money gained when paid more than what it costs to provide something in return, such as a service or product or both. It’s imperative for owners to determine both how much is needed to sell and how much to sell it for, to not only cover costs but also make a profit.

In the interior design industry, profit is commonly generated from markup and design service fee or time billing.

A common misconception among interior designers is that profit margins and markups are the same thing. A markup is the profit as a % of the cost price, while a profit margin is the profit as a % of the selling price. For example, a pillow that cost $100 with a markup of 30% would result in a selling price of $130. However, the profit margin on that same pillow would only be 23%, because it is dividing the markup ($30) by the selling price ($130). With the 23% profit margin being lower than the 30% markup, the question then becomes, why does this matter?

It's important to identify and distinguish these two numbers because the markup must be high enough to generate the profit margins needed to cover both the product and service costs as well as the company’s operating expenses and produce an overall company net profit.

Another common misconception among designers is that time billing results in 100% profit margins. This is typically because the cost of the employees or non-billable hours are not being factored into the calculation. Owners must quantify their personnel costs and non-billable hours to better understand true profit margins related to time billing revenue.

Generally, a healthy profit margin in the interior design industry ranges between 30-40%, while an average profit margin ranges between 20-30%. The key, however, is that the profit margin is sufficient to sustain the operations of the business. One way to determine this is to put a financial plan with set goals in place through budgeting and forecasting. These reports can help owners identify their target markups required to generate their desired profit margins and overall company profits.

THE MOST OVERLOOKED NUMBER FOR INTERIOR DESIGN BUSINESSES: EQUITY

Equity may be one of the most important numbers for interior design owners to focus on, yet it may be one of the most overlooked. Equity represents the amount left in the company after subtracting its liabilities from its assets, in other words, the company’s net worth. It indicates the financial health of the business and allows owners to determine whether the company is gaining or losing value over time.

Positive and increasing equity typically indicates a healthy and growing company. Two common ways interior design business owners can increase their equity are:

1. invest more of their own cash or assets into the company.
2. increase the company’s overall profits and leave those profits in the business.

Positive equity can provide owners with opportunities they may not otherwise have, such as:

1. having a safety net in place in case the business starts to lose money.
2. having an opportunity for expansion if the business wants to grow.
3. using the equity as collateral if the business needs to borrow money or raise investor funding.

Negative equity on the other hand, can occur when the company’s liabilities exceed its assets or when the company incurs losses greater than the combined value of shareholder payments and accumulated earnings from prior periods. Common ways owners decrease their equity include:

1. withdrawing money from the business.
2. increasing the company’s debt interest payments.
3. generating company losses and losing money.

NEGATIVE OR DECREASING EQUITY MAY SIGNIFY FINANCIAL DISTRESS FOR THE BUSINESS OR BE VIEWED AS A STRONG INDICATOR OF IMMINENT BANKRUPTCY.

However, it may also be a result of the early start-up stages of the business requiring large amounts of capital that will later yield company profits. Either way, it’s important for owners to understand the distinction and what their negative equity represents, as it may require putting a plan in place to improve the company’s overall financial health and bring it to a positive number.

So, bottom line:

Interior designers, know your numbers.

2024 Independent Contractor Ruling

The US Department of Labor recently issued a new rule regarding the classification of independent contractors. The ruling aims to provide clearer guidance to employers and workers to ensure proper classification and compliance with FLSA regulations. This rule took effect in March 2024 and includes several key elements:

Multifactor Analysis: The rule uses a "totality-of-the-circumstances" approach, examining several factors, including:

• Opportunity for Profit or Loss: Based on the worker's managerial skill, and ability to make influential decisions and increase profit.
• Degree of Control: The level of control the employer has over the worker.
• Investments by Worker and Employer: The financial investments made by both parties.
• Permanence of the Relationship: How permanent or temporary the working relationship is.
• Integral Part of Business: Whether the work performed is essential to the employer’s business.
• Skill and Initiative: The worker’s use of specialized skills and business initiative.

Economic Dependency: The primary consideration is whether the worker is economically dependent on the employer for work. This broad interpretation aims to protect workers from misclassification and ensure they receive due wages and benefits.

Implications for Interior Design Firms: This change is expected to make it more challenging for employers to classify workers as independent contractors. Employers across various industries, especially those heavily reliant on subcontracting and services agreements like the design industry, may face increased scrutiny and legal challenges.

Employers should review their current worker classifications and contracts to ensure compliance with the new rule. Consulting legal counsel can help reduce risks associated with misclassification.

Misclassifying an employee as an independent contractor can lead to significant consequences for employers, including liability for back wages and penalties.

Additional information can be found on the Department of Labor's website.

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